Certain embodiments of this invention alter the traditional methods and processes by which employers provide retirement benefits to their employees. Thus, a brief discussion of employer-sponsored retirement benefits may aid in the comprehension and understanding of this disclosure.
The traditional scheme upon which government and industry has relied in providing employer-sponsored retirement plans is based upon the concept that asset accumulation and lifetime payouts are separate functions that cannot be combined into a single process, and must be maintained under multiple, separate plans. This means that employers offering retirement plans as part of their employee benefits programs offer them in the form of a “Defined Benefit Plan” (the “DB Plan”), a “Defined Contribution Plan” (the “DC Plan”), or a combination of the two. DB Plans have been designed to provide a lifetime income stream which the employee cannot outlive, while DC Plans have been designed to allow employees to accumulate assets to which they have access during their retirement years. Many employers have viewed both types of plans as being necessary for a financially secure retirement for their retirees, but have been forced to establish relatively cumbersome and separate processes in order to provide for both lifetime payouts and asset accumulation.
DB Plans are generally known by employers and employees alike as “pension plans.” These plans are designed to insure monthly payments to retirees which they cannot outlive. Employers, governments and unions adopted these plans to cost effectively allow their employees to retire with a measure of dignity and comfort well past the years that they could be gainfully employed. Conceptually, DB Plans operate much like very simple insurance companies. A DB Plan funds the lifetime payouts to retirees from the general assets of a plan, much like an insurance company funds lifetime payouts to annuity holders from its own assets. The retiree does not have any claim against any particular asset of the employer or the DB Plan. They have only the promise of lifetime payments from the employer.
Just as insurance companies are heavily regulated by state and federal authorities in order to protect an annuity policy holder's lifetime guarantee, so too are DB Plans heavily regulated. An entire regulatory scheme has been developed to insure that private employers sponsoring DB Plans have the financial wherewithal to fulfill this promise of lifetime benefits. There is even a set of rules under which DB Plan sponsors are required to purchase insurance from a quasi-governmental agency (the Pension Benefit Guarantee Corporation, or the “PBGC”) to protect a portion of retirees' benefits should employers be unable to fulfill their funding obligations.
The benefits provided by DB Plans are well defined (thus the term “defined benefit”). Typically, the accrued benefit is based upon a formula which multiplies a particular retiree's years of service by some sort of measure (such as a dollar amount like “
25” or a percentage like “ 1/12% of final average pay”). The DB Plan participant typically has no actual account balance which is “theirs” and over which they have investment control, rarely has the opportunity to make contributions to the plan, and (except for a very narrow class of DB Plans) has no access to the assets which fund the lifetime benefit.
Unlike insurance companies, however, employers who sponsor DB Plans are not in the business of developing and providing sophisticated annuity products to meet changing employee and market needs. They often do not have the skills or the resources to provide a wide variety of features to their lifetime payout benefits which can adapt to change. Employers are severely restricted by a regulatory scheme which discourages innovation. Though these employers are seeing the changing nature of their workforce and retiree population, they find that the DB Plan is unable to meet employee and retiree demands. DB Plans are, for the most part, proverbial “one trick ponies,” whose inflexibility has limited their usefulness in the current marketplace.
DB Plans are now in a state of decline. The number of DB Plans peaked in 1986 at 172,642 plans, and has since fallen to 26,000 plans in 2004, covering approximately 20 million workers. Meanwhile, DC Plans increased from 544,985 plans in 1986 to 840,301 plans in 2004, covering 51 million workers. (U.S. Department of Labor Private Pension Plan Bulletin, Winter 2001-2002, and Employee Benefit Research Institute).
For all of the above reasons, DB Plans are proving to be inadequate to the task of providing lifetime retirement income for an employer's retirees.
DC Plans provide for asset accumulation over a working career, instead of a guaranteed monthly benefit to retirees. DC Plans define how much an employer or employee can contribute to the plan, such as by specifying a percentage of annual compensation, or as a “matching” contribution based upon an employee's own contributions into the plan, and thus the term “defined contribution.” The most popular of these types of plans are called “401(k) plans,” though there are other types of DC Plans in existence. The retirement benefit provided by these plans typically consists solely of the account balance that the retiree accumulates while working, either through their own payroll deductions or through employer contributions.
DC Plans offer some solutions to employers concerns about DB Plans. Participants in a DC Plan maintain control of investments by selecting investment choices and, upon retirement, have full access rights to the accumulated account value. DC Plan account balances are “portable,” meaning that an employee can “rollover” his or her account balance into either an IRA or, upon getting another job, to another employer's DC Plan. No insurance premiums are due to the PBGC. No actuarial computations are required. There are no minimum finding rules for most types of DC Plans. DC Plans are available to younger and older employees alike. Employees have access to finds for certain types of emergencies. There are no funding liabilities from a DC Plan which show up on a company's balance sheet. The plans are much simpler to administer and the benefit is readily visible to all employees.
A DC Plan is also attractive to employees because of the variety of investment options which are typically made available. Unlike a DB Plan, under which the employee has no investment control, the fiduciaries of a DC Plan have the ability to select and provide a series of different types of investments to plan participants, and permit employees to transfer funds between these investments as their personal situations change. DC Plans also permit periodic withdrawals under certain hardship conditions, and allow participants to borrow money from their accounts at favorable interest rates.
The decrease in DB Plans has been accompanied by an increase in DC Plans. As DC Plans replace DB Plans, employers are attempting to fashion solutions which provide some level of income protection for retirees in addition to asset accumulation and control. A common approach for DC Plan retirement distributions is to provide retirees with a “systematic withdrawal” option, which they can adjust periodically to offset increases in the cost of living. This is accomplished by the retiree directing the plan to pay monthly amounts from his or her account balance, until such time as the retiree dies or until the account value becomes zero. The withdrawal rate and actual return earned will greatly influence the length of the withdrawal period. However, there currently is no lifetime guarantee available with systematic withdrawal programs from DC Plans. If the withdrawal rate is set too high, investment performance may not be sufficient to provide for long term income for the participant. If the withdrawal rate is set too low, investment performance may be sufficient to provide for a long term income for the participant, but the participant's standard of living may be compromised. A balance, therefore, must be maintained and constantly monitored.
As a result, even with all of their attractive features, DC Plans fail to adequately protect retirees' interests beyond the years in which they can be gainfully employed. DC Plan account balances can, and do, run out. With increasing life expectancies and the possibility of decreasing social security benefits, more and more individuals may be living to advanced ages faced with the prospect of outliving their retirement savings. Currently, a 65-year old has a 55% chance of surviving to age 85. For a couple age 65, there is a 30% chance one of them will live to age 95. (Source: A2000 Individual Annuity Mortality Table).
Employers are faced with a conundrum: how do they provide a flexible retirement benefit which will protect retirees through their waning years, while preserving the valuable features of a DC Plan? There are three options currently available, none of which adequately address retirement needs:
1. Adopt both a DB and DC Plan. This “two plan” process is inflexible, expensive, does not permit the consolidation of the two benefits in the design of a retirement scheme, and is very limited in the types of lifetime income benefits that are made available.
2. Adopt a DB Plan with a benefit stated in terms of an account balance, a so-called “Cash Balance” plan. This approach lacks most of the favorable features of a DC Plan, including not typically allowing for additional employee contributions and permitting neither equity participation nor participant investment control.
3. Adopt a DC Plan which allows for payouts over a “life expectancy” rather than guaranteeing a lifetime payout; or amending a DC Plan to permit the purchase of an annuity which is not integrated with an employer-sponsored plan.
While employers can use these options to address some of the concerns discussed, they do not provide integrated retirement programs. There is, therefore, a need for processes by which an employer can provide additional forms of lifetime income to retired employees through use of existing platforms of employer-sponsored retirement plans.